Why Bernanke’s not doing more

I don’t think there’s all that much difference, in reality, between the Ben Bernanke we saw at today’s post-FOMC press conference, on the one hand, and Mohamed El-Erian, criticizing Bernanke’s decision, on the other. Both of them say that Fed action at this point is a second-best solution to the economic problems facing the US: what we really need — and aren’t going to get — is fiscal, not monetary, stimulus.

Bernanke got quite a few questions today asking why he wasn’t being more aggressive; certainly extending Operation Twist by a few months is unlikely in and of itself to make much of a noticeable difference to anything. As Joe Weisenthal points out, if the market thought that Operation Twist would actually boost US growth, then the announcement should have sent long bond yields up; instead, then went down.

That said, all markets are distorted right now by what you might call Global Zirp. El-Erian worries about the long-term implications, without quite coming out and saying that they’re unavoidable:

What this continued Fed activism will do is to continue altering the functioning of markets, contaminate price discovery and distort capital allocation. Already, the viability of several segments – from money markets to insurance and from pension provision to suppliers of daily market liquidity, all of whom provide financial services to companies and individuals – has been undermined. The Fed has also conditioned many market participants to believe in a policy put for both equities and bonds. And other government agencies are relieved to have the policy spotlight remain away from their damaging inactivity.

Of all the things to worry about right now, price discovery and capital-allocation distortions are pretty low down the list. I’d happily do enormous damage to both of them if I thought it would do any good in terms of creating jobs. I’d even come out and say I’d spend a trillion dollars buying broad stock-market index funds below a certain level. There’s no point in fetishizing market liquidity and shadow-banking institutions like money-market funds if they don’t actually help workers rather than savers.

On the other hand, if your non-standard techniques aren’t going to do any good anyway, there’s no point in hurting markets — and the less that the Fed does now, the more dry powder, at least in theory, it has to respond to a European meltdown or the fiscal cliff.

At one point in the press conference, a reporter from Nikkei asked Bernanke if the US is in a liquidity trap. Bernanke didn’t answer directly, but the indirect answer was yes: there are things that central banks can and should do to stimulate the economy even when interest rates are at zero, he said, and we’re doing them. Paul Krugman would disagree, of course. But it was clear from the press conference that Bernanke feels as though he has at least some extra ammunition in the back of his armory in case things get worse still. Which raises the obvious question: why isn’t he using that ammunition now?

The view of the committee is that that would be very reckless. We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

From today’s presser, my feeling is that Bernanke maybe doesn’t feel as strongly any more that he would be reckless to act more aggressively. But he does still feel that the upside from doing so is “doubtful”. If he’s forced by crisis to pull out the ammo, he’ll do so. But Bernanke clearly doesn’t consider the unemployment crisis to be a crisis in that sense. If something happens suddenly, then policymakers can act strongly and decisively. Years of high unemployment are in many ways more damaging than the sudden drop in government spending that risks arriving with the fiscal cliff. But because the damange is slow-acting and invidious, it seems that unemployment, on its own, is incapable of persuading Bernanke to do more.